The ambiguous applications of private credit funds in India

The ambiguous applications of private credit funds in India

Alternative funds are poised to maintain their status as the most rapidly expanding segment within India’s investment arena. This growth has been facilitated by a regulatory approach that is relatively hands-off: Serving as channels for foreign capital influx into the nation, the industry has benefited from considerable flexibility. However, with local savers becoming increasingly involved, anticipate a shift away from the unrestrained practices of private funds as regulatory scrutiny intensifies.

Alternative funds will continue to be the fastest-growing segment of India’s investment landscape.

Numerous high-performing private investment vehicles thrive in India, yet it is the select few established for questionable motives that may attract heightened regulatory scrutiny to the country’s rapidly expanding asset class.

The most egregious instances of misuse within these alternative investment funds have thus far been observed among nonbank finance companies. Some of these entities have utilized these specialized structures primarily for regulatory arbitrage.

In instances where major borrowers, particularly in real estate projects, faced potential defaults, certain financiers turned to newly created funds tailored for them by Wall Street firms. Investors who pooled their funds were issued senior securities, entitling them to interest. The finance company also contributed, but in a smaller junior tranche that holds a lower position in the repayment hierarchy and is the first to absorb any losses.

These private funds subsequently extended loans to the same distressed borrowers who, in turn, repaid their original loans, sidestepping bankruptcy proceedings. The finance companies were content as well, as any mark-to-market losses on the securities they now held were considerably lower than the provisioning burden they would have borne in the event of credit deterioration.

This is how certain shadow lenders in India have engaged in “evergreening” their loan portfolios to evade the scrutiny of the Reserve Bank of India, their regulatory authority. However, the Securities and Exchange Board of India (SEBI), the stock-market watchdog, has caught on to this maneuver. According to a Reuters report in October, the SEBI has identified at least a dozen cases, involving $1.8 billion to $2.4 billion, where alternative investment funds have been exploited to circumvent various financial regulators, including the RBI.

Nevertheless, the trend won’t be limited to the affluent alone. Participation from domestic institutions is poised to rise as well, especially when insurance and pension firms are granted greater flexibility to invest in alternative assets. This shift will indirectly introduce the typical Indian saver to the affluent individual’s domain, underscoring a significant reason why the Securities and Exchange Board of India (SEBI) cannot afford to overlook dubious financial structures.

While a global private equity sponsor purchasing a riskier portion of a fund might be standard practice, concerns arise when a local nonbank finance company not acting as the sponsor provides a loan-loss cushion to enhance its balance sheet or when a major international retailer employs a fund to navigate around New Delhi’s foreign direct investment limits. Regulators are displaying impatience in the face of such practices.

The prevailing sentiment favors SEBI. The US Securities and Exchange Commission, led by Chair Gary Gensler, implemented rules in August to tighten oversight on hedge funds and private equity. Industry associations have contested these regulations, asserting that the SEC has overstepped and that the new rules “would fundamentally change the way private funds are regulated in America.”

This is likely why SEBI is taking proactive measures. In India, the alternative-asset industry spans venture capital and hedge funds as its two extremities, with private equity and private credit forming the substantial middle ground. In just a decade, these two asset classes have transformed from a $200 million sideshow to commanding $83 billion, comprising more than four-fifths of the $100 billion committed by investors to private funds.

If historical growth is any indicator, it won’t be long before the industry accumulates enough influence to flex its lobbying muscles, both in New Delhi and Washington, to resist regulatory constraints. Presently, SEBI faces challenges in this regard, as reported by the Economic Times in July, with an ongoing tussle between the regulator and the fund lobby.

The stakes are escalating on both ends. Alternative funds are predicted to persist as the fastest-growing segment of India’s investment landscape, as highlighted by a report from CRISIL, an affiliate of S&P Global Inc. This growth has thrived on lenient regulation, benefiting from the latitude provided as conduits for foreign capital into the country. However, as the local saver becomes increasingly entangled, the era of unbridled practices among private funds is anticipated to draw to a close, especially in light of questionable deals by global private equity firms that make such an outcome inevitable.

Andy Mukherjee is a Bloomberg Opinion columnist. Views do not represent the stand of this publication.  

Credit: Bloomberg 

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